SECOND EDITION · 2008. 7. 15. · § 4.09 Reading, Questions and Problems 96 A. Reading 96 B....

PARTNERSHIPTAXATION

SECOND EDITION

RICHARD M. LIPTON, ESQ.Partner, Baker & McKenzie LLP

PAUL CARMAN, ESQ.Partner, Chapman & Cather LLP

CHARLES FASSLER, ESQ.Member, Greenebaum Doll & McDonald PLLC

WALTER D. SCHWIDETZKYProfessor of Law

University of Baltimore School of Law

GRADUATE TAX SERIES

LexisNexis

TABLE OF CONTENTS

Acknowledgments v

INTRODUCTION THE SPIRIT OF PARTNERSHIPS ANDPARTNERSHIP TAXATION 1

CHAPTER 1 DEFINING PARTNERSHIPS AND PARTNERSFOR TAX PURPOSES 11

§ 1.01 Introduction 11

§ 1.02 The Existence of a Business Entity 11

§ 1.03 Classifying Partnerships for Tax Purposes 13

A. The Nature of Partnerships 13

B. The Classification of Domestic Business Entities 14

C. The Classification of Non-U.S. Business Entities 15

D. Reclassifying Partnerships as Corporations 16

1. An Election Under Treas. Reg. § 301.7701-3 16

2. Publicly Traded Partnerships 16

3. Taxable Mortgage Pools 17

§ 1.04 Distinguishing Partnerships From Other

Contractual Arrangements 17

A. Distinguishing Partnerships From Loans 18

B. Distinguishing Partnerships From Service Agreements 19

C. Distinguishing Partnerships From Leases 19

D. Distinguishing Partnerships From other

Co-Ownerships 20

§ 1.05 Determining who is a Partner 21

§ 1.06 Electing out of Subchapter K 23

§ 1.07 Aggregate and Entity Theories of Partnership Taxation . . . . 24

§ 1.08 Comparison with S Corporations 25

§ 1.09 Reading, Questions and Problems 26

A. Reading 26

B. Questions and Problems 26

CHAPTER 2 FORMATION OF THE PARTNERSHIP 31§ 2.01 Introduction 31

vn

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§ 2.02 Transfer of Property to Partnership 31

A. General Rules 31

B. What Constitutes Property 32

1. Cash 32

2. Contract Rights 32

a. Promissory Notes 32

i. Contributor's Promissory Note 32

ii. Third Party Note 32

iii. Installment Note 33

iv. Partnership's Indebtedness to the Partner 33

b. Right to Acquire Property 35

3. Services 35

4. Assignment of Income 35

5. Right to Use Property 36

6. Recapture Property 36

7. Inventory and Unrealized Receivables 37

8. Recapitalizations 37

C. When Is Property Contributed? 38

D. Effect on Depreciable Assets 39

E. Stock of Corporate Partners 39

F. Disregarded Entity Becoming Partnership 39

G. Underwritten Partnership Interests 40

§ 2.03 Transfers to Investment Companies 41

A. Taxability of Transfer 41

§ 2.04 Effect of Receipt of Boot ' 42

§ 2.05 Effect of Liabilities 42

§ 2.06 Basis of Partnership Interest to Partner 43

§ 2.07 Holding Period of Partnership Interest 44

§ 2.08 Partnership's Basis For Contributed Property 45

§ 2.09 Partnership's Holding Period For Property Received 45

§ 2.10 Character of Gain or Loss From Sale of

Contributed Property 46

A. Contributions of Ordinary Income Assets 46

1. Unrealized Receivables 46

2. Inventory Items 46

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B. Contributions of Capital Loss Property 46

C. Tax-Free Transfers 47

§ 2.11 Organization And Selling Expenses 47

A. Selling Expenses : 47

B. Organization Expenses 47

§ 2.12 Reading, Questions And Problems 48

A. Reading 48


CHAPTER 3 OUTSIDE BASIS AND ALLOCATION

OF LIABILITIES 51


§ 3.02 Relevance Of Outside Basis 51

A. Gain or Loss 51

B. Limitation on Loss 51

C. Effect on Distributions 52

1. Cash Distributions 52

2. Property Distributions 52

§ 3.03 General Rules For Computing Basis 52

A. Starting Point 52

1. Capital Contributions 53

2. Purchase of a Partnership Interest 53

3. Gifts 53

4. Inherited Partnership Interest 53

B. Adjustments to Basis of Partnership Interest—Generally . . . 53

C. Special Adjustments 54

1. Tax-Exempt Income 54

2. Natural Resources Property 54

3. Nondeductible Expenditures 55

4. Distributions 55

D. No Negative Basis 56

E. Time for Computing Basis 56

F. Ordering Rules 56

§ 3.04 Effect of Partnership Liabilities 57

A. General Rules 57

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B. Definition of Recourse and Nonrecourse Liabilities 58

1. Definition of Liability 58

2. Definition of Recourse Liability 58

3. Assumption of Liability 61

4. Definition of Nonrecourse Liability 61

5. Bifurcated Liability 61

C. Allocation of Recourse Liabilities 62

D. Allocation of Nonrecourse Liabilities 63

E. Contributions and Distributions of Encumbered Property . . . 65

F. Tiered Partnerships 66

G. Sales of Partnership Interests 67

H. Anti-Abuse Rule 68

1. Assumption by Partnership 68

2. Transfer of Partnership Interest 69

3. Assumption of § 1.752-7 Liability 70


A. Reading 70


CHAPTER 4 OPERATION OF THE PARTNERSHIP:CALCULATION OF PARTNERSHIPTAXABLE INCOME 73


§ 4.02 Pass-through Nature Of Partnership 73

§ 4.03 Computing Income, Gain, Loss, Deductions and Credits

of Partnership • 73

A. Generally 73

B. Taxable Income of the Partnership 74

C. Separately Computed Items 74

1. Gains and Losses From Sales 74

2. Charitable Contributions 75

3. Dividend Income 75

4. Foreign Taxes Paid 75

5. Other Items 75

D. Bottom Line Profit or Loss 76

TABLE OF CONTENTS xi

§ 4.04 Elections 77

§ 4.05 Accounting Method 77

A. C Corporation is Partner 77

1. Farming Business 77

2. Qualified Personal Service Corporation 78

3. Small Corporations 78

B. Tax Shelters 80

1. Registered Offering 80

2. Syndicate 80

3. Tax Shelter 81

C. Farming Partnerships 81

1. Partnerships Having Corporations as Partners 81

2. Farming Syndicate 82

§ 4.06 Characterization 82

A. Dealer Status 82

B. Holding Period 83

C. Hobby Loss Rules 83

D. Like-Kind Exchanges and Involuntary Conversions 83

E. Discharge of Indebtedness Income 84

§ 4.07 Loss Limitation Rules 84

A. Basis Limitation 84

B. At Risk Rules 85

1. Limitations on Losses to Amount at Risk 85

2. Calculations of Amount at Risk 85

3. Nonrecourse Financing 86

4. Carryover of Disallowed Losses 87

5. Applicability to Partnerships 87

6. Disposition of Activity or Partnership Interest 88

C. Passive Loss Limitation 88

1. Loss Disallowance Rule 88

2. Passive Activity 89

3. Material Participation 90

D. Disposition of Partnership Interest 91

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§ 4.08 Taxable Year of Partnership 92

A. Required Taxable Years 92

B. Business Purpose 95

C. I.R.C. § 444 Election 96


A. Reading 96


CHAPTER 5 OPERATION OF A PARTNERSHIP:ALLOCATION OF PARTNERSHIPINCOME AND LOSSES 101


§ 5.02 Capital Accounts 102

§ 5.03 Substantial Economic Effect Rules 103

A. Introduction 103

B. Economic Effect Rules 103

1. "Regular" Rules 103

2. Alternate Economic Effect Rules 106

3. Economic Effect Equivalence 109

C. Substantiality 109

1. General Rules 109

2. Shifting and Transitory Allocations 110

3. Depreciation/Recapture Gain Chargebacks 112

4. Tax Credits 113

5. "q" Adjustments 113

§ 5.04 Partner's Interest in the Partnership 114

§ 5.05 Book-tax Disparities—I.R.C. § 704(c) Allocations 115

A. Introduction 115

B. I.R.C. § 704(c) Methods of Allocation 117

1. The Traditional Method 117

2. Traditional Method with Curative Allocations 118

3. Remedial Method 119

4. Depreciation 120

5. Other Considerations 121

C. New I.R.C. § 704(c)(l)(C) 122

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§ 5.06 Reverse I.R.C. § 704(c) Allocations 123

§ 5.07 Allocations of Nonrecourse Deductions 125

A. Introduction 125

B. The Regulatory Safe Harbor 127

C. Subsequent Nonrecourse Borrowing 131

§ 5.08 Family Members as Partners 132

A. Introduction 132

B. Pre-I.R.C. § 704(e) Case Law 132

C. I.R.C. § 704(e) 133

§ 5.09 Changes in Partnership Interests During the Tax Year . . . . 134


A. I.R.C. § 704(b) 135

B. I.R.C. § 704(c) 137

C. Nonrecourse Deductions 138

D. Family Allocations 139

E. Changes in Partnership Interests During the Tax Year 140

CHAPTER 6 DISPOSITIONS OF PARTNERSHIP

INTERESTS 141


§ 6.02 Recognition of Gain or Loss 141

A. Amount Realized 141

B. Basis 142

§ 6.03 Character of Gain or Loss 143

A. General Rule 143

B. Unrealized Receivables and Inventory Items 143

1. Ordinary Income Recognition 143

2. Unrealized Receivables 143

3. Inventory Items 144

§ 6.04 Holding Period 145

§ 6.05 Installment Sales 145

§ 6.06 Dispositions Other Than Sales or Exchanges 146

A. Gifts and Charitable Contributions 146

B. Death of a Partner 148

C. Exchanges of Partnership Interest * 148

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D. Abandonment and Worthlessness 149

E. Conversion to Corporation 150

F. Transfers to Other Partnerships 151

§ 6.07 Optional Adjustment to Basis of Partnership Property 151

A. I.R.C. § 743(b) 152

B. Making the I.R.C. § 754 Election 153

C. Effect of I.R.C. § 743(b) 154

D. Computation of Transferee's Proportionate Share

of Adjusted Basis 155

E. Allocation of Basis Adjustment Among Partnership Assets . . . 156

F. Additional Aspects of Adjustment 158

1. Transfer of Partnership Interest 158

2. Distribution of Partnership Property 158

3. Contribution of Property to Lower-Tier Partnership 158

4. Contribution of Property to Corporation 159

5. Computation of Income and Expenses 159

6. Special Basis Adjustment and Depreciable Property 159

7. Return Filing Requirements 160

§ 6.08 Allocation of Income and Loss 161

A. Closing of Partnership Taxable Year 161

B. Sale of Entire Interest 161

C. Methods of Allocation 162

D. Sale of Less Than Entire Interest 162

E. Anti-Abuse Rule 162

§ 6.09 Termination of Partnerships 163

A. What Transactions are Taken into Account 163

B. Computing Capital and Profits 165

C. The Twelve Month Rule 166

D. Effect of Partnership Termination 166

1. Transactions Deemed to Occur 166

2. Employer Identification Number 166

3. Elections 167

4. I.R.C. §§ 704(c)(l)(B) and 737 167

5. Depreciation and Amortization 167

TABLE OF CONTENTS xv


A. Reading 168


CHAPTER 7 PARTNERSHIP DISTRIBUTIONS 171


§ 7.02 Nonliquidating Distributions of Money 171

§ 7.03 Nonliquidating Distributions of Property 172

A. General Rules 172

B. Outside Basis Less Than Inside Basis 173

C. Marketable Securities 174

§ 7.04 Capital Accounts 176

§ 7.05 I.R.C. § 732(d) 176

§7.06 The Sale of Distributed Property 177

§ 7.07 I.R.C. § 734(b) Adjustments 178

A. Introduction 178

B. The Devil is in the Details 179

C. Mandatory "As If" I.R.C. § 754 Elections 182

§ 7.08 Shifts in Ordinary Income Property 183

A. Introduction 183

B. Unrealized Receivables and Substantially

Appreciated Inventory 183

C. The Nuts and Bolts 185

§ 7.09 Liquidations of Partnerships and Partnership Interests . . . . 191

A. Introduction 191

B. Liquidations of the Partnership or of a Partnership Interest .,. 191

C. I.R.C. § 736 Payments 193

1. Introduction 193

2. I.R.C. § 736(a) Payments 194

3. I.R.C. § 736(b) Payments 195

4. Allocating and Taxing I.R.C. § 736 Payments 195


A. Nonliquidating Distributions 199

B. I.R.C. § 734(b) 200

C. I.R.C. § 751(b) 201

D. Liquidations \ . . . 201

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CHAPTER 8 TRANSACTIONS BETWEEN PARTNERAND PARTNERSHIP; ISSUANCE OF APARTNERSHIP INTEREST FOR SERVICES . . . . 203


§ 8.02 The Different Roles of Partners in Transactionswith a Partnership 203

§ 8.03 Payments to a Partner as a Partner Other

Than Guaranteed Payments 203

§ 8.04 Guaranteed Payments 204

§ 8.05 Payments to a Partner Other Than in His or Her

Capacity as a Partner 205

§ 8.06 Disguised Sales 208

A. The Disguised Sale of Assets 208

B. The Disguised Sale of Partnership Interests 214§ 8.07 Limitations on Recognition of Losses and

Recharacterization of Gainsin Related Party Transactions 217

A. Limitations on Recognition of Losses 217

B. Recharacterization of Gains 218

§ 8.08 Issuance of a Capital Interest in Exchange for Services 219

A. Background 219

B. Explanation of Provisions of the Compensatory

Interest Proposed Regulations 220



A. Reading 222B. Questions and Problems 222

CHAPTER 9 BUSINESS COMBINATIONS: PARTNERSHIP

MERGERS AND DIVISIONS 227


§ 9.02 Partnership Mergers 227


B. Form of a Merger 229

C. Built-in Gain Resulting from the Merger 231

D. Buy-Out Rule 233

§ 9.03 Partnership Divisions 234


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B. Form of a Division 236

C. Built-in Gain in Divisions 236

§ 9.04 The Effect on the Partners and the Partnership 237


A. Mergers and Acquisitions 238

B. Corporate Divisions 239


CHAPTER 10 PARTNERSHIP OPTIONS 243


§ 10.02 Background for Noncompensatory Options 243

§ 10.03 Scope of Proposed Regulations onNoncompensatory Options 246

§ 10.04 Issuance, Lapse, and Straight-Forward Exercise ofNoncomensatory Options 246

§ 10.05 Complications on the Exercise of

Noncompensatory Options 249

A. New Partner Enters While Option Outstanding 249

B. Corrective Allocations 254

§ 10.06 Option Holder Treated as Partner 256

§ 10.07 Compensatory Options 259

A. Issuance of a Compensatory Option 260

B. Exercise of Compensatory Option 260

C. Repurchase or Sale of Option 260

D. Effect of Outstanding Option 261

E. Recharacterization Rule : 261

§ 10.08 Reading 262

CHAPTER 11 I.R.C. § 197 INTANGIBLES AMORTIZATION . . . . 263


§ 11.02 Summary Of I.R.C. § 197 263

§ 11.03 General Rules Applicable To

Partnerships Under I.R.C. § 197 264

A. Contributions 264

B. Distributions 265

C. Terminations .l. . . 266

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D. Basis Adjustments 266

E. Allocations in Regard to Built-in Gain 267

§ 11.04 Anti-churning Rules Applicable to

Partnerships Under I.R.C. § 197 268


B. Contributions 270

C. Distributions 271

D. Adjustments to Basis of Partnership Property 273

E. Partner's Use of Partnership Property 276



A. Reading 277


CHAPTER 12 FOREIGN PARTNERSHIPS, FOREIGNPARTNERS AND PARTNERSHIPS WITHTAX-EXEMPT ENTITIES 279


§ 12.02 Foreign Partnerships 279

A. Classification 279

B. Foreign Tax Credit Rules in Regard toForeign Partnerships 280

C. Controlled Foreign Corporations as Partners inForeign Partnerships 281

D. U.S. Source of Income Rules in Regard to

Foreign Partnerships 285

E. The Hybrid Entity Rules 285

§ 12.03 U.S. Partnerships with Foreign Partners 286

A. General Rules Relating to U.S. Taxation of

Foreign Persons . 286

B. Withholding Obligations in Regard to FDAP Income 289

C. Withholding in Regard to Income Effectively

Connected with a U.S. Trade or Business 289

D. Branch Profits Tax 291

E. Disposition of Interests in U.S. Partnerships byNon-U.S. Persons 291

§ 12.04 Partnerships with Tax-exempt Entities 292

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A. Impact on the Organization's Exempt Status 292

B. Unrelated Business Taxable Income 293

C. Debt-Financed Income 295

§ 12.05 Limitations on Deductions Allocable to Property

used by Tax-exempt Entities 297

A. General Rule on Limitation on Losses 297

B. Special Application to Partnerships 298

C. Exceptions 299

D. Application to Like-Kind Exchanges and Condemnations . . . 300



A. Reading 301


CHAPTER 13 ANTI-ABUSE PROVISIONS 305


§ 13.02 Judicial Doctrines 305

A. Introduction 305

B. Substance Over Form 306

C. Business Purpose 308

D. Step Transaction Doctrine 309

E. Failure to Form a Valid Partnership for Tax Purposes 310

§ 13.03 Anti-abuse Regulations 311

§ 13.04 Mixing Bowl Transactions 314

A. Introduction 314

B. I.R.C. § 707(a)(2)(B) 316

C. I.R.C. § 704(c)(l)(B) 316

D. I.R.C. § 737 319

E. I.R.C § 707(a)(2)(A) 321

F. I.R.C. § 732(f) 322


A. Reading 323


SECOND EDITION · 2008. 7. 15. · § 4.09 Reading, Questions and Problems 96 A. Reading 96 B....

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Transcript of SECOND EDITION · 2008. 7. 15. · § 4.09 Reading, Questions and Problems 96 A. Reading 96 B....